(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)
Call it “Sue-on-Pay – The Sequel.”
In 2011, several public companies faced lawsuits after losing their Say-on-Pay shareholder advisory votes on executive compensation mandated by the Dodd-Frank Act. As reported in this prior post, a few of these first generation “Sue-on-Pay” lawsuits resulted in settlements, while many since that time have been dismissed. However, in early 2012, a new round of compensation-related lawsuits began, and these lawsuits use a new tactic that presents real dangers. Companies need to use caution in preparing proxy materials for annual meetings, especially in certain cases as described below.
The plaintiffs in this new round of cases have sued over 20 companies prior to their annual meeting, seeking to enjoin shareholder votes based on purported incomplete or misleading disclosures. See “‘Say on Pay’ and Executive Compensation Litigation: Plaintiffs’ New Racket”, posted on the D&O Diary blog by securities litigation attorneys Bruce Vanyo, Richard Zelichov and Christina Costley of the Katten firm. The cases focus on two types of shareholder vote: (1) the Say-on-Pay vote and also, very often, (2) a separate shareholder vote to increase the share authorization of an equity plan (a “share authorization vote”). The attempt to delay vital corporate activities through litigation is similar to the tactic that has been used successfully over the past several years by plaintiffs’ lawyers in merger and acquisition-related litigation. If the litigation threatens the timing of the important events, the defendant company will often be willing to agree to a settlement to end the litigation so life can go on. For a new comprehensive discussion of the impact of the M&A litigation, see “The Trial Lawyers’ New Merger Tax” (download) issued by the U.S. Chamber Institute for Legal Reform.
Vanyo, et al. report that several companies have settled the compensation-related cases in 2012, notably Brocade Communications Systems, Inc. In that case brought in California state court, plaintiffs claimed various disclosure deficiencies in the proxy statement, including failure to include projections of future stock grants under the plan and planned share repurchases, as well as the failure to include the board’s peer group analysis of share usage under the plan. The court issued an order enjoining the share authorization vote. In the ensuing settlement, the company had to delay for a week the portion of the annual meeting involving the share authorization vote. The company was forced to file a supplemental proxy statement in which it disclosed, among other things, the board’s internal projections regarding future stock grants. As is often the case in these types of settlements, the only cash payment was up to $625,000 in fees to plaintiffs’ counsel.
Comment. Reportedly, some of these second-generation Sue-on-Pay lawsuits have been brought solely in connection with the disclosure in the Say-on-Pay advisory vote. However, in Brocade and the other cases where plaintiffs have reportedly been successful in obtaining injunctions and/or achieving settlements, the common denominator is that the company was also seeking an increased share authorization for an equity plan. Although I don’t have access to the courts’ rulings or the settlement documents in all of these cases, I believe plaintiffs can present these share authorization vote cases in a more compelling way:
- For many companies’ proxy statements in the past few years, the share authorization vote disclosures have been given less thought and scrutiny than the compensation discussion and analysis section that sets the stage for the Say-on-Pay vote. Often, the share authorization disclosure describes the equity plan in detail but gives little or no background on how the requested amount of the share authorization was chosen, the company’s share usage or the board’s intentions in connection with share usage going forward. Therefore, it is fairly straightforward for plaintiffs to pick apart these disclosures and point out alleged deficiencies.
- The applicable SEC disclosure rule for share authorization votes (Item 10 of Schedule 14A) includes disclosure requirements that relate to some of the deficiencies claimed by counsel in Brocade. (In contrast, the rules for Say-on-Pay votes themselves include no substantive disclosure requirements, but rather refer to the other compensation disclosures, which are usually more polished.) For example, Schedule 14A requires that the proxy statement disclose the number of options to be received under the plan, “if determinable,” by executive officers as a group and other specified persons and groups. In practice, companies generally don’t include these disclosures, because the amounts are not considered to be determinable prior to the compensation committees’ actual decisions to make the awards. Even though the Brocade plaintiffs apparently did not base their argument on this point, a future plaintiff might be able to convince a court that the proxy disclosure rules were not followed adequately.
Therefore, it is reasonable to assume that plaintiffs will have better luck getting traction with cases that involve a share authorization vote than in cases that involve only a Say-on-Pay vote. In fact, there is some anecdotal evidence that lawsuits that relate solely to a Say-on-Pay vote may be defended more readily by the company with less likelihood of a delay in the annual meeting. For example, we have learned of two recent court cases involving annual meetings where there the only compensation-related item on the agenda was the Say-on-Pay vote - there was no share authorization vote. In both cases, plaintiffs’ motion for a TRO was denied by the court in time to hold the annual meeting as originally scheduled. This blog post by Cornerstone Research describes one of the cases, involving Symantec.
Recommendations. At least in the near future, it is likely that these lawsuits to enjoin shareholder votes will continue. Therefore, as other commentators have pointed out, companies should use caution and make sure their compensation disclosures are as complete and accurate as possible.
I would add that companies that intend to seek share increases in the share authorizations for their equity plans should be especially cautious. The proxy disclosures on this topic should be as complete as possible. If the board has considered analyses of share usage or projections of future grants, the company might consider including summaries of this information in the proxy statement. Further, practitioners should take a fresh look at Item 10 of Schedule 14A and err on the side of more disclosure.
For a company that is uncertain about whether to seek an increased share authorization in 2013, my advice would be to delay that vote until 2014 if possible. By that time, the litigation may have died down, or strategies to defeat such lawsuits may be clearer.